Toys ‘R’ Us Directors Face New Fraud Claims Over Bankruptcy

(Bloomberg) -- Toys “R” Us board members and owners face new allegations of fraud and breach of duty over the company’s 2017 bankruptcy.

Creditors claim in ongoing litigation that seven company directors have now said they knew they shouldn’t have approved executive bonuses and onerous bankruptcy loans at the outset of the case that put the retailer on the fast track to a sudden liquidation six months later. 

The additional debt served to keep Toys “R” Us in business during its restructuring, but cost it more than $500 million in fees and interest and came with strict terms, or covenants, court documents show. The costs were borne by trade creditors and employees who continued to work with the company on the promise of a successful turnaround, but went unpaid when it couldn’t comply with the debt terms and shut down.

Meanwhile, the owners and directors who signed off on the ill-fated financing received immediate bonuses of as much as $2.8 million as part of the plan, according to the filings. The creditors allege the authorization of those bonuses violated federal criminal law. 

“Baseless” Claims 

A lawyer representing the company’s former executives and directors previously has called the creditors’ lawsuit “baseless” and said the group would defend against it “vigorously.” The defendants’ lawyers didn’t immediately respond to a request for comment on the latest documents. 

The collapse of Toys “R” Us involved a little-anticipated bankruptcy filing in 2017 that set off a months-long effort to restructure the company in bankruptcy court before it ultimately liquidated early the next year. The company had struggled for a decade with a crushing debt load from its 2005 leveraged buyout by Bain Capital, KKR & Co. and Vornado Realty Trust. 

The directors revealed in pretrial depositions that they knew the company couldn’t comply with the terms of its bankruptcy debt before they approved, according to filings by Tru Creditor Litigation Trust, a creditor group. Financial forecasts the directors describe reviewing in August 2017, before the bankruptcy commenced, showed the company would breach a liquidity covenant by January 2018. 

The company’s breach of that covenant marked the beginning of a pivot to abandon the restructuring effort and wind operations down. 

Knowing the turnaround wasn’t feasible, the company’s owners and directors should have ordered a liquidation to begin in August 2017 to preserve the ability of Toys “R” Us to repay its employees and creditors in full, the creditors say. 

“This was not merely poor judgment,” lawyers for the trust said in the filings. Rather, “defendants took the path that advantaged their personal interests to the detriment of the company.” 

The case is Toys “R” Us Inc., 17-34665, U.S. Bankruptcy Court, Eastern District of Virginia (Richmond).

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